Minutes of the Monetary Policy Committee’s first meet of the current fiscal showed all members have shifted focus to rein in inflation amid continuing policy normalisation as Russia’s invasion of Ukraine pushes inflation even higher.
Policy Making: Nuanced and Nimble
The domestic inflation outlook presented in the February 2022 MPC meeting has undergone a significant upward shift since the start of the war on Feb. 24, with the escalation of conflict and subsequent turmoil in global commodity markets, Governor Shaktikanta Das said, according to the minutes of the April MPC resolution published Friday.
The liquidity rebalancing operations of the RBI have prepared the market for this normalisation of the LAF corridor, Das said. While the risks to domestic growth call for continued accommodative monetary policy, inflationary pressures necessitate monetary policy action. The circumstances warrant prioritising inflation and anchoring of inflation expectations in the sequence of objectives to safeguard macroeconomic and financial stability, while being mindful of the ongoing growth recovery, the governor said.
Central Bank’s Goldilocks Moment?
The view that increasingly occupies centre stage is that irrespective of whether supply bottlenecks are the driver or pent-up demand, it will become more difficult to tame inflation the longer the fight is delayed, Deputy Governor Michael Patra said in his remarks.
“Whether the jump in oil and other commodity prices will be short-lived or not is not known; but if these prices ignite and levitate the prices of other goods and services sympathetically, the fear will gain ground amongst the public that inflation is going to stay high for a while, and this can end up becoming a self-fulfilling prophecy.”
Patra asked will central banks deliver the perfect disinflation, the so-called soft landing? Or will they overshoot the runway and precipitate an unwanted recession on a world weary with pandemic woes, war and worn and torn supply chains? The view gaining ground is that inflation is at heights that have shattered glass ceilings and the only way to excoriate it is to force a recession—the so-called hard landing, he said.
Geopolitical risks appear overwhelming at this juncture and over the foreseeable near term. The RBI has been preparing for the tail risks in either direction, he said.
If, as the projections show, inflation persists in high reaches, the drainage of liquidity already achieved and planned for the year ahead will reduce risks of excess liquidity fanning inflationary pressures and posing threats to financial stability. If, on the other hand, risk sentiment improves globally and India receives large volumes of capital flows, the standing deposit facility expands the capability of the RBI to undertake full and seamless sterilisation without running out of instruments. This will help to keep monetary expansion consistent with the outlook on inflation and growth, Patra said.
Reconsideration Of Outlook
The sharp changes in the broader global economic environment that have now unfolded require a reconsideration of the economic outlook and the policy responses, MPC Member Shashanka Bhide said.
As the shocks to the price conditions are essentially on the supply side, emanating from the external sector, unless the potential of domestic demand conditions to sustain higher prices is reduced, inflation pressures would rise further, he said.
What has changed clearly for the consumers and producers in March is the price rise for fuels and some food items in what appears to be a first-round impact with the full pass-through of the rise in the international prices yet to be complete, Bhide said.
Response to the evolving price conditions and broad-based policy measures to effectively bring down inflationary pressures without disrupting the favourable environment for sustaining growth are now needed, he said.
Pause Or Raise Rates
With some recovery and high commodity prices, it will not be necessary to cut repo rates further. Future policy will either pause or raise rates, Ashima Goyal, member of the MPC, said.
Rebalancing of liquidity started in 2021, and has now reached a level, with new facilities to absorb liquidity, that is compatible with raising policy rates. Short rates are set to rise to make the repo rate the operational policy rate again, she said.
It is time now to withdraw crisis-time accommodation in terms of moving towards the equilibrium or neutral real rates consistent with non-inflationary growth, she said. As long as rates remain below this, it is still not a tightening regime, she explained. When rates are below neutral because of excess crisis related accommodation, the initial rise only takes them towards neutral.
“A rate rise that responds to excess demand, as well as to persistent inflation, so that the real rate adjusts smoothly and does not deviate too far from equilibrium will best be able to anchor inflation expectations yet sustain the growth recovery while minimising market volatility and output sacrifice.”
Communication Is Key
“I refrain from discussing whether, on balance, the changed situation warrants immediate action on the policy rate for the simple reason that the forward guidance given in the last meeting effectively precludes such action,” MPC Member Jayanth R Varma said. It is important to maintain the credibility of monetary policy communications, and deviation from prior forward guidance should be made only under truly exceptional circumstances, he said. “In this backdrop, maintaining the policy rate at the current level is the only sensible choice, and I therefore vote to keep the policy repo rate at 4%.”
With inflation projected to breach the upper tolerance limit for several months, it is imperative for the MPC to communicate its resolve to ensure that inflation remains within the target going forward, Varma said.
“In the extremely uncertain situation that prevails today, it is very important for the MPC not to issue any forward guidance that would tie its hands,” he said. It is necessary to communicate clearly that in future meetings, the MPC would consider itself completely free to take any action on the policy rates that may be warranted by the data that becomes available in the coming weeks, he said.
Focus On Low And Stable Inflation
Recovering to pre-pandemic trend should not guide monetary policy at this stage and policy should focus on non-inflationary sustainable growth in the economy, Mridul Saggar, executive director at the RBI, said.
A close watch on inflation expectations is necessary, Saggar said. If expectations are rising, especially if they turn unhinged and start rising faster than even actual inflation, monetary policy would have to reign in expectations to prevent a self-sustained inflationary spiral, he explained.
Headline inflation has stayed elevated for long and has tested tolerance, he said. A close watch on inflation expectations is necessary. If expectations are rising, especially if they turn unhinged and start rising faster than even actual inflation, monetary policy would have to reign in expectations to prevent a self-sustained inflationary spiral, he stated.
“The best way to support growth on a durable basis is to have a strong commitment to low and stable inflation.”
Considering the emergence of a different growth-inflation trade-off, it is best to start withdrawing monetary accommodation through liquidity and rate actions that can begin with raising the floor and normalising the corridor, he said. The policy will still stay accommodative as rates, even after lifting nominal rates, will stay below real neutral rate for foreseeable future.
“Monetary policy is not a rocket science, but the timing of the launch of the rocket is nevertheless important as monetary policy transmits to its final goals with long and variable lags,” Saggar said. With a flatter Phillips curve, tackling inflation becomes that much harder as it may call for larger output sacrifice. So, a deft policy mix is needed, he added.
